Vodafone verdict: Need for extensive change in tax laws

The Supreme Court has ruled that Indian tax authorities have no jurisdiction over Vodafone's purchase of Hutchison's interest in its mobile telephony joint venture in India with Essar, as the deal was executed through sale of a holding company registered in the Cayman Islands.

The ruling is a setback not only for India's fight against tax havens but also for taxation in general. For, the court's privileging of form over substance, maintaining the corporate veil, could lead to elaborate and extensive tax planning that results in enormous leakage of revenue.

The implication is clear. The judges are interpreting the law as it stands. India needs to rewrite its tax laws, to enable it to deal with commercial practice in a globalising world.

If every ABC Ltd operating in India is henceforth not to be owned through a holding company registered in some tax haven or the other, so as to permit acquisition by XYZ Ltd through its holding company registered in another tax haven without paying any capital gains tax, the language of tax law will have to make it clear that what counts is whether value accrues to the company changing ownership because of its economic activity in India.

For a range of businesses, even the requirement of having assets in India might not be relevant. Should India's tax laws forsake revenue from transactions of such businesses? The verdict also sets a precedent for other deals. Justice Radhakrishnan, in his ruling, says that such imposition of tax amounts to capital punishment on capital investments. This, clearly, is not a legal opinion.

The tax dispute could have been avoided had Vodafone the facility of seeking an advance ruling on the transaction. However, the authority for advance ruling (AAR) works within a timeframe that can only be described as other-worldly.

This must change. General Anti-Avoidance Rules that guard against sharp tax practices, without bestowing arbitrary powers on the taxman, need to be framed in the coming Budget. A treaty override - where domestic law overrides a bilateral tax treaty - would also be in order.

Misuse of the Mauritius tax treaty is another agenda that needs to be pursued with vigour.